Yahoo Still Has Room To Run

Thesis Overview:

Yahoo!'s (YHOO) stock has gained ~30% in the past two months after the company's 3rd quarter earnings release coupled with new leadership (i.e., Marissa Mayer) taking the helm in July of this year. The company has laid out a long-term strategy to better monetize its current content offerings, invest in mobile, and re-focus on its core business. Yahoo!'s recent divestiture of almost half its Alibaba Group stake was indeed a catalyst that gave the market some optimism that Mayer was a CEO who could get things done and follow through on her promise of a re-focused Yahoo!. This equity investment, along with the company's Yahoo Japan JV, are valuable assets that are still not being appropriately valued by the market. Our view is that at $19-20 per share, you are buying Yahoo!'s core Display and Search business at a steep multiple discount to its competitors' trading levels, and if Mayer is able to follow through on a turnaround plan, then there is even further upside to the stock. We would be patient in accumulating share due to the recent run-up, but we do see a further 25-30% upside in the stock in the coming year, the reasons for which are discussed in our detailed report.

Company Overview:

Yahoo! is a digital media company that delivers personalized digital content and experiences to millions of users in 60 countries, regions and territories around the world. Yahoo! offers 3 main categories of online properties to users in addition to marketing services designed to connect users with Yahoo! and with its network of 3rd party affiliates. The company's 3 categories of offerings as well as a description of each are as follows: Communications & Communities, Search & Marketplaces, and Media. Yahoo! generates most of its revenue from the display of graphical advertisements ("Display revenue") and the display of text-based links to advertisers' websites ("Search revenue"). Advertisers can pay the company on a per click basis (a "click through") or on a per impression basis (a "page view") in an effort to draw users to their own websites.

Competition and Evolution:

Yahoo! has essentially given up on trying to win over new users through its propriety search engine, and has partnered with Microsoft (NASDAQ:MSFT) to use its search algorithms when users go to Yahoo.com to search the web. Thus, Yahoo! is closer in competition with AOL Inc. (AOL), however it has been regaining market share and has grown topline (excluding TAC) by 1% during the first 9 months of 2012, compared to AOL's 5% decline in revenue excluding TAC. Thus Yahoo! trades at a premium to AOL at 5.8x forward EBITDA, yet as we will get into in the valuation section, the market is actually valuing its core business as a much steeper multiple discount.

EBITDA Valuation:

Marking Yahoo!'s Alibaba and Yahoo Japan equity investments on a mark-to-market value basis, and also factoring in Yahoo!'s current cash and marketable securities position, in addition to its liabilities, we get to a remaining (or "core") enterprise value of $1.9 billion. This means that Yahoo!'s core offerings (Display, Search and Other) are valued at approximately 1.2x LTM EBITDA and 1.1x 2013E EBITDA on a pre-tax basis. Some folks look at Yahoo! on an after-tax basis, assuming a zero cost basis in its Alibaba and Yahoo Japan stakes, taxing the sale of these entities at 37% (roughly the tax rate on recent Alibaba sale gains). This analysis yields Yahoo!'s "core" business trading at 4.2x and 3.9x LTM and 2013E EBITDA, respectively … Still at a discount to comps. For simplicity's standpoint, let's look on a pre-tax basis as (1) we don't know when these assets will get monetized, which could be in a few years meaning the market values of these investments could be substantially larger than currently as they are both growing at a rapid pace; and (2) when comparing price to book value, both are on a pre-tax basis. If we assume some sort of multiple expansion to reach the realm of AOL's EBITDA valuation (4-5x EBITDA), then Yahoo! looks more like a $25/share stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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